NARRATOR: Trade



Principles of Economics

by N Gregory Mankiw

The Video Series script

Principle #5 Trade Can Make Everyone Better Off

Trade. We do it every day of our lives. People trade money for goods. So do businesses... And nations... Trade is the lifeblood of international economy. Every nation grows stronger and its economy improves as it exercises the principles of international trade.

There are two elements to a well-balanced trade relationship: comparative advantage and specialization.

Economists use the term “Comparative Advantage” when describing the opportunity cost of two producers. The producer who has the smaller opportunity cost is said to have a comparative advantage in producing that good.

To see the benefit of comparative advantage, let us examine two countries, America and Japan, and two goods, food and cars.

For our example we will assume that both countries produce cars and grow food. In both the U.S. and Japan, a worker can each produce one car per month. Because America has more land it is more efficient at producing food than Japan. A U.S. worker can produce two tons of food per month, whereas a Japanese worker can produce only one ton per month.

If America is as efficient as Japan at car manufacturing and better at food production, why do we need to trade with her?

Because the opportunity cost of producing a car is two tons of food in the U.S., but only one ton of food in Japan. So, Japan has a comparative advantage over the U.S. in producing cars.

Because it is less expensive for America to import cars than to produce them domestically and more profitable to export our surplus food than to try and consume it all internally, the U.S. has a comparative advantage in food production.

Once this comparative advantage has been determined, each country recognizes the need to specialize.

Japan can now spend more time producing cars and less time growing food while the U.S. can spend more time in the production of food and less time on the automobile assembly line.

Each country is now specializing in the production of a good in which it has a comparative advantage. In order to receive the good it is not producing, it must trade with the other. This trade relationship benefits both partners.

Such a relationship breeds an interdependence among trading partners.

In many ways, we as Americans tend to view the Japanese as our competitors in the global marketplace. After all, we both produce automobiles and food and are competing for the biggest possible market share of each.

But is it right to view this competition as a sports contest, where one side wins and the other side loses?

No. Such a limited view tends to ignore the positive benefits of interdependent trade to both countries. In fact, the opposite is true: Trade between two countries makes each country better off.

During the past thirty years, Japan’s comparative advantage and specialization is the manufacture of automobiles has led it to become a leading industrial power. Many believe that this growth has come at the expense of the American economy. But how true is this?

As Japan built up its comparative advantage in auto assembly, the United States was freed up to specialize in other markets where it could built up its own comparative advantage. These markets included finance, high technology and the manufacture of auto parts. Each of these markets are fundamental to the delivery of goods and services including the production of automobiles. By specializing in the areas of their comparative advantage, America and Japan are able to complement each other’s production.

By working together in trade, each side can guarantee that the final product is sold at the best price for the consumers of both countries. This allows for a greater number of purchasers for both the Japanese and American firms. Further, the more of these goods that are sold, the stronger the economy will be in each of the partner nations.

Such interdependent relationships are becoming more and more common as the global marketplace expands. This expansion of trade guarantees better economies and a brighter future for all nations involved.

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